Why Right Now Is a Good Time to Buy

Everywhere I go lately, I've been pummeled with the same question: "When will the market bottom?" It's usually asked in a tone of high anxiety, if not desperation.

It's almost enough to send me into hibernation. The short answer is, "I don't know." I have always steadfastly refused to predict where markets are headed in the short term. My premise is that the past is knowable; the future is not. Since this seems manifestly unsatisfactory to everyone asking the question, let me rephrase it.

First, it's possible that the market already has bottomed. On Monday the Dow Jones Industrial average and the S&P 500 closed at their lowest levels in 12 years. The Nasdaq may have bottomed last November. Needless to say, if the market has bottomed, you can relax and stop obsessing about it. You don't want to sell now. The fundamental goal of the Common Sense system is to buy lower, sell higher. Thus, you should never sell when the market hits a new low (or buy when it hits a new high.) Following this simple rule guarantees that you will never sell at the bottom nor buy at the top of a market.

But let's assume that the market hasn't bottomed, and will reach still-deeper lows. If you knew that for a certainty, would you sell all your stocks now? If you did, you could park the proceeds in something safe, like short-tem Treasurys, currently yielding practically nothing, or money-market funds, barely yielding 1%. You could then wait until the market hits another low.

Then what? Do you buy back in? Do you wait in anticipation of even lower lows? The problem is that at every milestone, the future is no more knowable than it was at the previous one. If you're a long-term investor, to profit from selling now requires an accurate assessment of when to buy back in (and if you're not a long-term investor, you shouldn't be in the stock market to begin with).

In other words, you have to be right twice about something that no one can know with any certainty. You can pursue this strategy if you wish, but don't pretend it's anything but rolling the dice —  twice.

Of course if you believe that the market will never recover, never again reach 7200 on the Dow, you should sell. That requires a complete loss of faith not just in the stock market, but in the productive capacity of all mankind. I suppose it would be the equivalent of a return to the Dark Ages, though in the absence of any economic statistics or any stock markets, it's hard to know how much progress may actually have been achieved during those centuries. By contrast, since records have been kept, stocks have outperformed every other investment category. This includes the period of the Great Depression, when they lost nearly 90% of their value, as well as the current 50% drop.

I have long advocated a strategy of buying into declines and selling into rallies, which is premised on the expectation that markets are periodically oversold and overbought. Since stock prices are predictions about future earnings, which are unknowable, they will never be entirely accurate, which creates periodic opportunities for investors. Given the tendency of stock prices to rise over time, the biggest risk for most investors is to overallocate to cash and to miss rallies, which can be swift and sudden. Given the current gloom about the economy and the markets, the risks of being underexposed to stocks now strikes me as especially acute. Even with the recent declines, we're not yet at the next buying threshold in the Common Sense system (1300 on the Nasdaq). But if you've been raising cash during the prolonged downturn, which means you've been very astute or lucky or both, you'll need to reinvest at some point. I see no reason not to start now, as long as you're willing to risk some short-term declines in return for long-term profits.

This strategy has nothing to do with the current state of the global economy, the health of the banking system, real estate prices, or corporate profits, all topics which have been dominating the business pages. But for what it's worth, I've been seeing some positive glimmers when it comes to the fundamentals, especially greater liquidity in the financial system, something of a rally in corporate bonds, even junk, and some firmness in commodity prices. People may quarrel about the details, but the large stimulus package, a comprehensive approach to the banking and financial system (see last week's column), a sensible approach to the foreclosure crisis, and an apparent willingness to confront the reality of the auto industry all strike me as important positive steps from Washington.

As I said at the outset, this is nothing but an elaboration on my short answer. I don't know when the market will bottom. But whether it's this week, this year or next, I'm confident it will.